YIELD TO CALL Seven years ago the Templeton Company issued 25-year bonds with an
ID: 2618872 • Letter: Y
Question
YIELD TO CALL Seven years ago the Templeton Company issued 25-year bonds with an 11% annual coupon rate at their $1,000 par value. The bonds had an 5% call premium, with 5 years of call protection. Today Templeton called the bonds. a. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Round your answer to two decimal places. b. Why the investor should or should not be happy that Templeton called them I. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they can now do so at higher interest rates. II. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates. III. Since the bonds have been called, investors will receive a call premium and can declare a capital gain on their tax returns. IV. Since the bonds have been called, investors will no longer need to consider reinvestment rate risk. V. Since the bonds have been called, interest rates must have fallen sufficiently such that the YTC is less than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates. Select- TExplanation / Answer
a.
Realized rate of return = Profit/Investment
Profit = selling price - Buying price + Interest
Selling price = Call premium = 1000*(1+0.05) = 1050
Interest = 7*1000*11% = 770
Realized rate of return = (1050-1000+770)/1000 = 0.82 = 82%
b. Option V.
Investor should not be happy
Since the bonds have been called, interest rates must have fallen such that YTC is less than YTM. Investors should reinvest their proceeds at a lower interest rate
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